Reliance Worldwide Corporation Limited (RWC) Earnings Call Transcript & Summary

Good day, everyone, and welcome to the RWC Fiscal Year '23 First Quarter Trading Update Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. Heath Sharp, Group CEO. Please go ahead, sir.

Good morning, everyone, and welcome to RWC's FY '23 first quarter trading update, which we've just announced to the market. This is Heath Sharp, and with me here in Melbourne is our CFO, Andrew Johnson. First up, I'd just like to apologize for the difficulties in connecting this morning, made us a few minutes late, but hopefully, everyone is now on and we're good to go. So we will start by making some brief comments on the first quarter. We will then open for questions from those joining by the conference call, followed by those on the webcast. On Slide 3 of our presentation, we have a summary of our first quarter performance. The headline is net sales growth of 23% for the quarter, which included a full quarter of EZ-FLO. During the period, U.S. dollar strength against most other currencies, including the British pound and the Australian dollar, adversely impacted reported sales. On a constant currency basis, sales growth was 28%. Excluding EZ-FLO constant currency sales growth was 6%. Having previously provided information with respect to July and August, the most relevant data points relate to September trading. We would note that we have continued to see volatility in sales month-to-month and region-to-region throughout the quarter. In summary, the Americas in September was a little lower than we had seen in the prior 2 months. EMEA was a little stronger and Asia-Pacific was broadly in line. Both EMEA and Asia-Pacific recorded lower intercompany sales, which adversely impacted their operating margins. Reported EBITDA was up 16%. This included the gain on the sale of a property in the U.K. of $15 million. We were able to sell the surplus property following the outsourcing of our freight logistics operations to a third party last year. We also incurred AUD 1.4 million in costs to achieve EZ-FLO cost reduction synergies. Adjusting for these 2 items, EBITDA was down 4% at AUD 53.2 million. Net debt finished the period at AUD 32.9 million lower than at 30th of June, principally due to the receipts from the sale of that U.K. property. I'll now hand to Andrew to step through the financials.

Thanks, Seth, and good morning, everyone. Turning to Slide 4, we provided an EBITDA bridge and more detail on margin drivers for the first quarter. We knew the first quarter would see tough margin comps versus the prior year. We recorded an adjusted EBITDA margin of 21.4% in the first quarter of FY '23, and that compares with a margin of 26.6% in the same period last year. The first quarter last year saw the highest margin of the year as higher commodity costs had not fully hit the P&L. While the first quarter of FY '23, we saw and expect that to be the lowest margin rate of the year where those results reflect input costs at their peak. The 3 major drivers of the margin percent decline were: one, lower volumes. Secondly, it was the dilution effect of the higher prices we implemented to offset cost inflation. And lastly, it was higher SG&A costs. As we've outlined previously, higher prices realized inflated the revenue line, but to the extent they only offset input cost inflation, the overall effect on margin is dilutive. In this quarter, this dilution impact and higher cost in our factories amounted to 240 basis points. The higher SG&A costs reflect wage and other inflation as well as an increase in marketing and travel expenses, which we plan to come back into the business. We have seen a return to a more normal level of business activity after 2 years of COVID, which has impacted SG&A. Unfortunately, the higher spend comes at a time when volumes have softened. Given the economic forecast and potentially tougher trading conditions ahead, we will be taking a fresh look at our cost base and reinvigorating our cost reduction program to make sure that our costs remain in line with our revenues. Expect more information on our cost reduction efforts at the half. Turning to Slide 5 and the Americas. Net sales were up 43%, driven by the EZ-FLO contribution. Excluding EZ-FLO, net sales were up 6% for the quarter. As we have said, we expect sales volumes to remain choppy, which is what we saw in the first quarter where July and September were soft, but demand in August was strong. Subsequently, trading in the first 2/3 of October has also been strong. While there has been some noise in the market with movements in customer ordering patterns, cutting through that noise, we feel that unit volumes in the Americas are generally down mid-single digits. FluidTech volumes were down versus the PCP, and we believe that the catch-up work in commercial and hospitality following COVID has now played out in that market. We continue to execute very well in terms of order fulfillment, and we finished the quarter with our highest order fulfillment rates we've had for quite some time. EZ-FLO had a very strong quarter with an adjusted EBITDA margin of 18.2%. This is the final period in which we will be showing EZ-FLO's EBITDA performance separately. As from 1st of October, we have fully integrated EZ-FLO reporting into the Americas and are no longer maintaining a separate P&L for the business. While it is disappointing that volumes were down on the PCP, we are mindful of the fact that we've had 2 very strong years from a volume growth perspective and a small retracement when viewed in a broader context isn't entirely unexpected given the challenging economic conditions. On Slide 6 and APAC. In APAC, we recorded further growth in external sales and volumes in the Australian residential and new construction and remodel market were up 3% on the PCP. This was offset to some extent by lower manufactured exports to the Americas as well as higher commodity input costs. Turning to EMEA on Slide 7, you can see they had quite a strong quarter with external sales up 7%. This was driven by 9% growth in U.K. external sales with plumbing and heating sales up 13%. This was certainly stronger than anticipated. Continental Europe sales were up 1%. FluidTech volumes have leveled off as for a period of strong growth. Intercompany sales in EMEA were down 24% due to lower volumes of FluidTech sold to the Americas, and this has had an impact on EBITDA performance along with higher input and other costs. Now over to Heath for the outlook and closing comments.

Thanks, Andrew. Turning now to the outlook on Slide 8. It is fair to say that economic conditions have deteriorated since we last presented to the market. The outcome being, frankly, that we have even less clarity around the economic outlook for most markets in which we operate. Nonetheless, we believe that our contractors' current backlog of [indiscernible]. We also believe that our concentration in repair and maintenance end markets positions us well regardless of the economic cycle. Of course, we are cautious as to how the next 9 months will play out. We are paying renewed attention to operating costs and cash generation. We are confident that we will continue to execute well in what is likely to be a challenging environment. Looking further ahead, as we presented at our Investor Day last month, we are tremendously optimistic about the opportunity ahead of us. We will continue to prudently invest in the business to ensure that we deliver on these long-term growth objectives. So we'll conclude the presentation there and now open up to questions. Thanks.

[Operator Instructions] And we'll take our first question from Daniel Kang with CLSA.

My first question is just the contraction in Americas volume of mid-single digits. Do you expect this to sustain through the FY '23 year? I guess my question is really on channel inventories. Just as you're looking to bring inventories back in line with sales volume, do you think your customers are similarly doing this?

Daniel, thanks for the question. Look, in trying to project what '23 looks like is just super difficult right now. I think as we've set out, best we can see looking through all the noise and volatility is the market in the Americas feels like it's off mid-single digits at this point in time. Now, as we set out month-to-month volatility is certainly evident. It's sort of been a down, up, down, up sort of a start to the year. I mean what next month looks like is just impossible to judge. I think we are seeing some volatility, particularly in the channels outside of retail. We're seeing volatility in ordering patterns. And when we get into our OEMs, we're seeing volatility driven by their manufacturing plans for their own reasons. As far as inventory is concerned, look, we are obviously looking at it closely, but we're also in a period where we need to build inventory for the end of the half as we approach the winter cycle, which is our normal process. So in some cases, we're managing to bring inventory down and other products inventory sort of is building as we plan and I think the second half is going to be the major move for us from an inventory point of view. So look, there's a lot going on trying to read through all of it's really tough trying to project that out from there is even more difficult. That's sort of the environment we're in.

Just a real quick second question on the positive. A very strong margin performance at EZ-FLO, EBIT margins of over 16%. Now, given cost price moves and further synergy benefits, I realize that you won't be reporting EZ-FLO numbers going forward, but where do you see normalized EBIT margins?

Look, we're certainly pleased with where it got to. Some months ago, we were a little behind where we'd expect it to be. We put extra focus on that and have moved that into a better position. As Andrew said, though, that business is now integrated and it's really tricky to now determine whether our actions or EZ-FLO actions or legacy RWC actions because they just overlap so much from our product and a channel and customer point of view. But that approach that we took to EZ-FLO when we weren't comfortable where the margins were at and where the pricing actions were at and the cost actions were at, that's the approach we take to the entirety of the business. I think it's fair to say we've got a renewed focus on that operational executional side of the business, and we'll be looking to sort of make improvements where we can across the whole business going forward.

And our next question will come from Lisa Huynh with JPMorgan.

So, just on the price rise of 7.3% in the first quarter. Can I just confirm that they equally felt across the region?

No, it's not equal across the region.

Okay. So I guess on a year-on-year basis, have we fully cycled the impact of price rises now in your view?

No, I don't think so, Lisa.

Okay. Sure. And then I guess, what's the view around deflation, I guess, as we enter the second half and the commodity prices start coming off?

Look, certainly, we're seeing easing in a lot of areas. It's still a little bit sporadic. I think as Andrew pointed out, right now with our lag, we're actually seeing essentially peak costs right now, which was certainly a driver in the margin in the first quarter. And we expect that to improve through the rest of the year. I don't want to get too far ahead of our skis on inflation. We thought this time last year, we were through it and then war broke out and whatever else has happened. So our mindset today is, look, you deal with what's in front of you on a given day, you focus on execution and you get to do it all again tomorrow. I'm sure that's an unsatisfactory answer, but that's sort of the reality of the last couple of years really, so.

Sure. I understand Heath. I appreciate the answer. And I guess the U.K. is still quite strong. Is there anything you can kind of put this down to just given the anecdotes we've had out of that region?

Look, not particularly. We were certainly pleased with how that market's continued through July, August, September. We continue to watch it. I think it's fair to say October's felt a little bit softer in both Mainland Europe and also the U.K. How that tracks through the rest of the month and then going forward is hard to know. I don't think there's anything specifically over there although, again, I'd point to the fact that a lot of our product is used in repair and maintenance, which is at the less discretionary end of the spectrum. I mean that no doubt helps us there as it does in the Americas.

Our next question will come from Brook Campbell-Crawford with Barrenjoey.

Just one on seasonality. Are you able to help us a bit with the 1Q into 2Q seasonality if we focus on sort of group EBIT? Historically, the first quarter has been ahead of the second quarter, but take your point around margins. So any sort of color around your current sort of demand trends persists and what we might sort of see in terms of 1Q, 2Q split at group EBIT for FY '23?

Look, I might jump in and start with. I guess my view sitting here is our historical seasonality sort of went out the window a couple of years ago with COVID. I mean we were looking yesterday, region-by-region at what the profile has been. And some regions and some product groups were down while others were just absolutely bursting through the roof and then 12 months later, it's gone the other way. So for me, it feels like our traditional seasonality is out the window. I guess I'd throw to Andrew in terms of what we see this year playing out based on our cost basis, in particular.

Yes. Brook, I would say historically, and use historically in quotation marks, the first quarter of our financial year is not going to be the strongest quarter of the year. You've got summer-times, vacations that certainly impacts EMEA but also in the U.S. That second quarter, we see a lot of customers typically preparing for winter just like we are. And sometimes, in some years, you can get what we call a freeze load-in in the second quarter. And that's historically what we've seen. I agree with Heath this year, it kind of feels like you can kind of set that aside and you won't see kind of those normal patterns this year. I just -- it just doesn't feel to me that we'll see that.

Okay. So just to clarify, is there a view on sort of 1Q, 2Q split this year or is it too difficult to say at this point?

I think it's too difficult to say.

Okay. That's fair enough. And just one, Andrew, for you, just on margins. The commentary over the last sort of 12 months has been sort of, ex EZ-FLO, EBITDA margin range of sort of 24% to 26%, that was a target anyway for the fourth quarter '22 and sort of landed in around the bottom of that range. Do you have a sort of a new target perhaps for that metric going forward, bearing in mind we effectively won't be able to back it out ourselves but within the business, do you have a view on what that range could look like going forward and what you're targeting?

Brook, I do have a view, but I'm not going to share that on the call. I think that we'll hold that one.

Yes. Okay. That's fair enough. One last one for me, if I can. But back in August, the commentary was for a 2% price increase in FY '23 based on just what had already been announced up until August. Effectively, you've done 7.6% in the first quarter. So I just want to reconfirm that 2% in FY '23 is still the right number or is there a revision to that on what you expect to roll through from price increases to-date going to be in FY '23?

I may bulk that up a little bit to around the 3% range. I will say, if you recall, last year, the business had very little price coming through in the first quarter last year. I mean, based on those margins, we had relatively little commodity inflation coming through last year. So that 7.9% year-over-year, that's going to decline in the following quarters as we start comping over a period last year with higher price than what we saw in the first quarter.

And our next question will come from Simon Thackray with Jefferies.

Three quickies. Just Ningbo, noting your comments that U.S. inventory is supporting sales for now and you're expect Ningbo to reopen, I think you said at the end of this week. How long can U.S. inventory support sales if we do see this extended lockdown in China?

Yes. That's a great question and quite a frustrating situation is, is if we can get moving again this week or even -- look, we -- the rest of this week down and even if the rest of next week was down, I think we're in an okay spot. Beyond that, we will then have to scramble a little bit, frankly. And look, that's not across the board. That will be particular containers that cause pain for a particular customer or a particular product group across a lot of customers. So I think we've still got a couple of weeks there where we'll be okay. If it stretches beyond that if we get into sort of 4 weeks of shutdown, that's a scramble.

Got it. Got it. So there's a sensitivity there, the longer that goes on in terms of the sales.

Sure. Sure. Sure. Look and it's like all business is the inventory, as we all know, is pretty robust, but there's always some key items in there that you need today. And if that happens to be the one you haven't got because the ship's delayed or you weren't able to ship, then it can have a big impact. If it's -- at the time, you can sell through for 3 weeks or 4 weeks, just depending on it's -- that's kind of been our supply chain environment for the last 12 months or so.

Okay, Heath. And then this probably links to a question for Andrew then. I mean you made the comment that we go into the winter build for inventory. So we need to build inventory in this quarter. If that's the case with the potential risk around Ningbo I'm not sure what happens to the balance sheet. And then as an adjunct to that, the extent of the inventory build and then what it means to the syndicated drawn debt where you've got the variable rate applying. And Andrew, just the extent to which you've seen that rate increase in the September quarter and what it's looking like in the December quarter for the syndicated debt.

Yes, there was a lot in that, Simon. As Heath said, in the first half of any year, but I think it's also the case in this year, we're going to make sure that we've got an appropriate quantity of our core SharkBite Push-to-Connect fittings that sell-through during a freeze activity. And so like every year, we're making sure that we're going to have adequate stocks. Our customers will have adequate stocks heading into that January timeframe. So don't expect an inventory reduction in this first half. We didn't see it in the first quarter, probably not going to see it in the second quarter. You will see inventory unwind in the second half of FY '23. And we are keenly focused on that. I have the regional CEOs and the regional CFOs very focused on those targets. And I feel pretty good that we're making momentum. But I will say it's taken us a little longer than expected to get that ship turned, but I expect that ship to turn in the second half of FY '23. In terms of our interest rate that we're seeing, if you recall, with our U.S. PP debt that we placed last year, roughly 45% of our drawn debt is fixed. And with the increase in rates now, that fixed rate is a little bit lower than what we're paying on the variable side. So we have seen an increase in the cost of debt over this quarter for our guidance.

Got it and expected. Yes. I saw that in the guidance, yes. And expect that, that goes, I guess, is a slight lag in that. So that goes higher again second quarter and potentially higher third quarter, yes. And then just quickly then when we're talking about things -- moving parts, raw materials relief, we've all been observing full in sort of nonferrous commodity prices and your comment about what's in stock and to be sold forward giving margin relief. Just to be clear, is that on a raw material basis, is that a third quarter event or a fourth quarter event, more likely in your view?

So based on what we can see in terms of the inventory valuation that's on our books today, you'll see a slight relief in the second quarter, but you'll really start to see it in the third quarter of this financial year and then continue through from the third to the fourth.

And our next question comes from Keith Chau with MST Marquee.

Andrew, perhaps the first question for you, trying to understand cash conversion in the quarter. If you look at the change in net debt ex property sale, I think it was up around AUD 7.7 million. There's a AUD 40 million dividend in there as well. So excluding dividends it looks like cash conversion was around the 70% or 80% mark. Can you confirm that my maths are correct, and what you're targeting for cash conversion for the full year? I would have thought if you are reducing inventory levels, perhaps your cash conversion for the full year could get into the 90% range.